An Economist Warns The World About The Potential For Financial Calamity

Financial panics have the nasty habit of quickly receding from popular consciousness when they've had little effect on day-to-day life. That's why it's important for Americans to recall just how close we came last fall to a financial calamity that could have rivaled the stock market crash of 1929 and recognize that for hundreds of millions of people in the developing world, the crisis that began in summer 1997 is far from over.

Within weeks of Russia's defaulting on its debts last August, the U.S. stock market plunged 19 percent. In the middle of the panic, Federal Reserve Board officials found themselves gathering top bankers in a boardroom in New York City to bail out the absurdly named hedge fund Long Term Capital Management, which had been speculating in Russian bonds, among other gambits.

Scenes like that hadn't been seen in financial circles since J.P. Morgan gathered the leading bankers of his day in his 5th Avenue mansion to put a halt to the great financial panic of 1907. Last fall, Fed Chairman Alan Greenspan, no garden variety alarmist, was forced to lower interest rates three times within seven weeks to counter what President Clinton only a few weeks earlier had called "the biggest financial challenge facing the world in a half century."

But how quickly things change in today's global economy. The stock market has fully recovered and then some. Federal Reserve Board meetings barely merit news coverage beyond the financial press. And several of the nations whose economies took the steepest plunge during what financial writers called "the global financial crisis" appear to be, if not what they once were, at least on the mend. Was the crisis nothing more than a short-term panic, leaving little for average mortals to fret about as the U.S. skates through its ninth consecutive year of economic growth?

Paul Krugman, the Massachusetts Institute of Technology economics professor turned pundit, thinks not. His fifth book, "The Return of Depression Economics," reminds his large following (he's a frequent contributor to The New York Times Magazine, Fortune and Slate, Microsoft's on-line magazine of politics and culture) that financial panics have not only arrived with greater frequency during the 1990s, but they've grown in intensity. This sometimes-controversial scholar-journalist says there is no reason to believe the next crisis won't make 1997-1998 seem like a picnic by comparison unless policymakers learn from their recent mistakes.

Avoiding for the most part the economics jargon that can befuddle mainstream audiences, Krugman's short book offers a quick synopsis of recent financial history. He begins his story in Hong Kong in July 1997 as that bastion of free-market virtue falls into the hands of the nominally communist People's Republic of China. The point, of course, is that free-market capitalism has triumphed everywhere.

But within weeks, Thailand's currency, the baht, collapses and sets off 18 months of escalating financial crises that roll through Asia, cross the Pacific to Latin America and nearly wash onto U.S. shores. Krugman ranges back to the Mexican peso crisis of 1995, which he sees as a missed opportunity for learning how to cope properly with the escalating crises of the 1990s.

He argues that each of these crises were classic panics. Short-term investors (whether U.S. mutual funds or European and Japanese banks) were looking for a quick killing and had poured money into these so-called emerging markets. The imbalances these investments created in the local economy allowed speculators to put pressure on the local currency, which sent the investors fleeing for the exits.

Krugman is at his best in describing the wild swings in Western attitudes toward the rapidly developing economies of East Asia. In the late 1980s, countries like South Korea and Thailand were part of an economic "miracle" whose partially state-managed economies were going to overwhelm the rest of the world. By the middle of the decade, they had become opportunities for Western investors. By late 1997, they were train wrecks, laid low by crony capitalism, the new name for close government-business cooperation that had once served Asia so well.

Krugman also spends a lot of time mulling Japan's unique fate. Hailed during the 1980s for its business acumen, that beleaguered country with the world's second-largest economy is now going through its ninth consecutive year of malaise. With Japan's aging population saving more and spending less, Krugman resuscitates a phrase coined by John Maynard Keynes to describe what is going on: a liquidity trap.